SIGNIFICANCE OF MANAGING OPERATING CASH FLOW
The proper management of operating Cash flow is essential because it defines a company's ability to generate a positive cash flow for running operations and growing the company. If cash flow is insufficient or negative, external funding may be necessary for business continuity, otherwise, the business will become insolvent. The Cash Flow statement is the source of operating cash flow data and it helps to understand, control and reconcile cash and profit. Proper management of operating cash flow is pertinent to ensure that a business always has enough money to pay its workers, suppliers and all operational expenses.
As is often said in business, Cash is King and proper monitoring through the cash flow statement helps to predict possible unfavourable future trends of cash flow in order to take the necessary precaution. Low or negative operating cash flow is not always necessarily bad. It may be a sign of huge investments or expansion made by a company with the potential to pay-off. However, where there are no signs of return over the expected period, this could be a sign of poor debt structure. On the other hand, a company with huge positive operating cash flow can cover both operating expenses and possibly re-invest.
The changes on the Cash Flow statement are as a result of movements or changes on the balance sheet during a particular period. These could be changes in fixed assets, working capital and/or equity. Financing costs (interest, dividends and tax) as reflected in the income statement also feed into the cash flow statement but do not affect operating cash flow. Operating profit (profit before interest) however, does affect operating cash flow.
HOW TEAM FS DECISIONS IMPACTED CASH FLOW
During the first year of the Winning Margin game, despite a loss of 21m as seen from the income statement, the team still managed to achieve a positive operating profit of 13m. This was largely fuelled by the huge decline in receivables (30m to 0m) as reflected on the balance sheet which meant more cash in circulation. The reduction in receivables was driven by (what????).Our decision to invest in additional machinery also slightly affected our operating cash flow by a 6 decline that year.
In year two, the teams operating cash flow dipped significantly to -83m as seen from the year 2 cash flow statement. This was as a result of a peaked investment in factory and machinery. Unfortunately, the operating profit was also low (-$18m) to cover this investment. Worst still, was the fact that an increased amount of receivables had been tied up ($31m seen on balance sheet) due to a mix of improper product production scheduling and choice of contract countries. Additionally, the choice of bigger contracts with the hope of making more money resulted in tying up cash in inventory ($22m from balance sheet) in an attempt to meet those large contracts.
Year three showed signs of recovery for both operating cash flow (-$83m to $4m) and operating profit (-$18m to $23m). To improve operating cash flow, there were more strategic decisions by the team to keep inventory low by selecting smaller sized projects. This led to a reduction in inventory of $20m, freeing up cash. Unfortunately, the amount in receivables remained quite high at $76m, thus still tying up a lot of cash. This was again, due to a mix of improper product production scheduling and choice of contract countries.
CONCLUSION
A major decision that affected our cash flow was around discounting. Over years one and two, the team sought to free up some money by discounting in order to quickly get receivables instead of taking loans as seen from profit and loss sheet. The actually had no resolving effect on our cash flow. This is because discounting affects profit but not cash and so by continuously discounting, we only compounded and shifted our cash flow issues to subsequent periods. We should have borrowed enough money instead, thus bringing in new money to cover our huge investments in the second year.
Overall, the teams operating cash flow moved from $13m to -$83m to $4m over the 3 years. The huge negative amount in the second year as mentioned was primarily due to investments and this necessitated the need to take a loan. Although the receivables amount could have been controlled through the better planning, the investments paid off as evident in increase in operating cash flow (-$83m to $4m) and operating profit (-$18m to $23m) by the third year.
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